Can Sirius XM's Business Model Last

Sirius XM’s business model has often been criticized, particularly for the fact that the company is perceived as too dependent on auto sales. But then again, this was also a topic of concern as the company was on the brink of bankruptcy a few years ago. With the stock having gained as much as 60% on the year, today’s version of Sirius XM represents what is possible when a company’s focus and its execution comes together. But the question still remain – is the model sustainable?

At one point, I was certain that Sirius’s business model could not last. But today, I can say I’ve grown “warmer” to the possibility that it can. Still, I’m not 100% there yet. As it stands, Sirius enjoys a large chunk of the auto market and it's growing each year. But it has not translated to growing profits - at least not to the extent that would please Wall Street.

On many levels, the current model is working. But in my opinion, it would serve the company well to try to attract more market share outside of the auto . It’s really simple – the more cars that are sold, the more subscribers Sirius gets. But for the stock to truly appreciate in value, Sirius must figure out a way to squeeze more profits out of the business. This is where it has fallen short.

By most standards, Sirius recently reported an excellent third-quarter. Revenues arrived at $867 million, which represents an annual increase of 14%. Likewise, adjusted EBITDA jumped to $245 million – growing year-over-year by 24%. Impressively, of the company’s 23.4 million total subscribers, 19 million are now paying for the service themselves once their promotional trials expire.

These metrics point to the fact that as car sales continue to rise, Sirius is signing subscribers at a record pace. The company is proving that not only is the model working, but as evident by the 2% churn rate, Sirius is able to retain the majority of the customers it gets – helping it amass $195 million in free cash flow during the quarter. So what’s the problem?

You might be thinking, the company the company is operating on all cylinders as evident by the growing number of subscribers, cash flow, revenues, EBITDA etc. In that regard, you would be correct. Unfortunately, it gets a bit more complicated from here. Though the model is working as well as it can, the execution has some unintended consequences. I say “intended” but I’m sure the company’s management is aware of these drawbacks.

For instance, as well as Sirius is performing in its ability to grow subscribers, it also costs the company more money for each new subscriber it acquires. The challenge comes when Sirius tries to squeeze as much profit as possible out of each subscriber. This is where it gets a bit more complicated. During the quarter, the company reported a 5% increase in subscriber acquisition costs.

Likewise, sales and marketing expenses grew higher by 10% year-over-year. Still, the company reported net income of $75 million. But this was 30% lower than Q3 of 2011. It would be fair to point out that during the quarter Sirius also retired $107 million worth of debt, much of which could have gone the bottom line. But it’s not all about one-time charges.

Sirius’s record rate of subscriber growth also meant that it had to pay 21% more in royalties. As a consequence to subscriber growth, costs of customer service and billings also grew. On the other hand, the company is doing very well in managing what it pays for content since costs in that area dropped by almost one point year-over-year.

Still, this was not enough to offset total operating expenses, which grew by 9% year-over-year. What it means is that in terms of subscriber growth, Sirius is getting good returns from what it spends. But as noted, for the stock to realize its full potential, the company must find a way to squeeze more profits out of the model.

Overall, the company is performing as well as it can. For that matter, very few companies have executed as well as Sirius over the past three years. Though I have been bearish for most of the year, the company has proven me wrong.

Still investing is about moving forward and investors want to know if Sirius’s current business model is sustainable. If the company’s expenses rise with every new subscriber that comes, I think it is fair to ask can Sirius do more with less. In other words, Sirius should find a way to get more money from current subscribers and focus less on acquiring new ones.

Bottom Line

With Apple now looking to enter the music streaming market to compete with Pandora, Sirius should consider leveraging its content partnership with Google and figure out a way to monetize current subscribers by redistributing content via YouTube.

As to whether or not the model can last, it depends on your point of view. But it will first require that Sirius figures out a way to grow outside of the auto – this has been my biggest concern, and likely continue to be. Nonetheless, until I see meaningful signs of declining revenue, I will consider the stock a good buy at these levels. This is despite the uncertainty that lingers with Liberty Media.